Cypen & Cypen  
Home Attorney Profiles Clients Resource Links Newsletters navigation
777 Arthur Godfrey Road
Suite 320
Miami Beach, Florida 33140

Telephone 305.532.3200
Telecopier 305.535.0050

Click here for a
free subscription
to our newsletter


Cypen & Cypen
OCTOBER 12, 2006

Stephen H. Cypen, Esq., Editor

Never Forget - September 11, 2001


The National Association of State Retirement Administrators has issued the results of its public fund survey for the fiscal year ending 2005. The survey contains data on a combined 12.8 million active members, 6 million annuitants and $2.26 Trillion in assets, representing approximately 88% of the entire state and local government retirement system community. (According to the U.S. Census Bureau, employees of state and local government represent more than 10% of the nation’s workforce. These employees are school teachers/administrators, firefighters, judges, police officers, public health officials, correctional officers and others providing myriad public services.) Perhaps the most recognized measure of a public retirement plan’s health is its actuarial funding ratio, derived by dividing the actuarial value of plan assets by the value of liabilities accrued to date. Most pension benefits for public employees are pre-funded, meaning that all or most of the assets needed to fund pension liabilities are accumulated during an employee’s working life, and paid out in the form of retirement benefits. Pre-funding is one way of financing a pension benefit. The opposite of pre-funding is pay-as-you-go, in which current obligations are paid with current receipts. In most cases, a pay-as-you-go pension plan eventually becomes too expensive to support with only tax receipts and contributions. Investment earnings account for most revenue generated by a pre-funded pension plan, reducing the need for contributions from employees and employers (taxpayers). A pension plan whose assets equal its liabilities is funded at 100% and is “fully funded.” A plan with assets that are less than its accrued liabilities is considered “underfunded.” However, underfunding is a matter of degree, not of kind. That is, underfunding is not necessarily a sign of fiscal or actuarial distress; many pension plans remain underfunded for decades with no detrimental consequences. The critical factor in assessing current and future health of a pension plan is not so much the plan’s actuarial funding level, as whether or not funding the plan’s liabilities creates fiscal stress for the pension plan sponsor. A plan’s funded status is simply a snapshot in an ongoing pre-funding process. It is a single frame of a movie that spans decades. There is nothing magic about a pension plan being fully funded and even with no changes to funding policies or plan design, most underfunded pension plans will be able to pay promised benefits for decades. Pension liabilities typically extend years into the future, and it is during this time that a pension fund can accumulate the assets it needs to funds its future liabilities. In addition to the actuarial funding ratio, other factors of a pension plan’s health include:


1. The funding amortization period

2. Required current and future contribution rates

3. Plan demographics

4. Sustainability and suitability of plan design

5. The plan’s governance structure

6. Fiscal health of the plan sponsor

7. The plan sponsor’s commitment to funding the plan.

Some important statistical findings from the survey: (1) the average actuarial funding ratio was 86.6%, (2) the predominant and median investment return assumption remains 8% (comprising 4% for inflation and 4% for real rate of return) and (3) the average allocation to equities and fixed income is relatively unchanged at 60.3/27.8. As always, kudos to Keith Brainard, NASRA’s Research Director.


According to Bloomberg News, U.S. investors added a net $835 Million to stock funds in a recent week, as deposits into exchange-traded funds exceeded outflows from mutual funds. Investors put $1.53 Billion into exchange-traded funds that buy stocks, while pulling $693 Million from equity mutual funds. ETFs are typically designed to mimic the performance of a basket of equities such as the Standard & Poors 500. Others track indices of commodities, bonds or currencies. Unlike mutual funds, which are priced once at the end of each trading session, ETF prices change continually as they are bought and sold throughout the day like stocks. Customers took out $1 Billion in mutual funds that invest in domestic companies and added $327 Million to funds that invest outside the U.S. Taxable bond funds had net inflows of $22 Million, while municipal bond funds took in $485 Million. Meanwhile, clients pulled $7.7 Billion from money market funds.


Manufacturing in the U.S. expanded last month less than economists’ forecast, suggesting the housing slump is extending its reach to other parts of the economy. The Institute for Supply Management’s manufacturing index dropped to 52.9, the lowest since May, 2005, from 54.5 in the prior month. A reading higher than 50 signals expansion. The index averaged 55.2 through August of this year. A decrease raises the risk that the economy will slow more than forecast heading into next year, and shows the Federal Reserve was justified in ending two years of interest rate increases in June. Corporate leaders, whose confidence has been rattled by a weakening real estate market and slower consumer spending, are reluctant to buy new equipment. The index was expected to fall to 53.5, based on the median of 64 forecast in a Bloomberg News survey. ISM surveys more than 400 companies in twenty industries, including clothing, printing, transportation, furniture and plastics to compile its index.


Freddie Mac and hundreds of banks and insurers may have to pay higher interest to sell bonds backed by mortgages and credit card loans under new accounting regulations. The Financial Accounting Standards Board will require investors to disclose changes in value of their asset-backed bonds in quarterly financial reports starting next year. Investors may demand five to ten basis points of interest in compensation for the risks that price swings will hurt earnings, according to research by RBS Greenwich Capital Market, reported by Bloomberg. Borrowers complain that the increase will hurt their profits and reduce trading in the $8.3 Trillion asset-backed market. The bonds now yield 72 basis points more on average than Treasuries with similar maturities. After setting records in each of the pas five years, sales of asset-backed bonds fell 18% in the first half of this year, $472 Billion, as consumer spending on auto sales declined.


Pennsylvania’s Auditor General has releases results of special performance audits and fiduciary reviews of the state’s two largest public pension plans: State Employees’ Retirement System ($30 Billion) and Public School Employees’ Retirement System ($57 Billion). The reports indicate that both funds were managed effectively and professionally. Nevertheless, the Auditor General identified several areas of administrative weakness that need to be tightened:

  • Improvements to how individual board members monitor and report conflicts of interest to improve transparency in governance.
  • Formalization of professional training for board members.
  • Improvements in the structure of internal audit operations to improve independence.
  • Changes to state law and fund policies to ensure that all board members are subject to a modern legal standard for judging their investment decisions.

SERS, with about 110,000 active and 101,000 retired plan members, has an 11-member board composed of elected and appointed officials. PSERS, with about 255,000 active and 150,000 retired plan members, has a 15-member board composed of elected and appointed officials. SERS was 93% funded and PSERS was 85% funded. (Both were more than 100% funded in 2002, but their total assets declined because of stock market losses and a 2001 decision by the General Assembly to increase employee retirement benefits while not addressing employer contributions. Duh.) SERS has a $2 Billion shortfall and PSERS is short about $9 Billion. The Auditor General suggested five steps that the General Assembly and Governor should consider taking immediately:

  • Impose a moratorium on adding new retirement benefits until the pension funds’ shortfalls are fixed.
  • Return the vesting period to 10 years, from 5 years, for new hires.
  • Identify other sources of revenue, such as gaming income and any other new funding sources that may be available in the future, to help fund pension costs.
  • The General Assembly should establish a rainy day fund that would make additional contributions to the pension funds during years of budget surpluses.
  • The General Assembly should pass a statute that requires the commonwealth to make annual contributions to SERS beyond 2007.

He went on to say that a pension solution will not be easy or painless. But whatever the General Assembly, the Governor and the pension funds do, they should strive to meet two objectives: first that the solution is financially prudent; and second, that it is fair to the employers, retirees and taxpayers alike. Sounds right to us. Predictably, the reports were well received by SERS and PSERS officials.

6. PENSION PLANS NOT CRAZY ABOUT FUNDS OF HEDGE FUNDS: reports on a global survey of 181 large pension funds worldwide by Mercer Investment Consulting that found 23% of money managers are happy with what they have gotten in return for their fund of hedge fund positions; 48% do not have an opinion and 28% are downright unhappy. (Only 48% of pension officials polled said they were happy with their hedge fund of funds manager.) And catch this one: just 58% of respondents even understand their fund of hedge funds manager’s investment approach. Surprisingly, fully one-third of pension funds surveyed actually invest in funds of hedge funds. Plus, of the pension plans that do not currently invest in funds of hedge funds, almost 20% say they are likely to do so within the next two years. Finally, more than a third of survey respondents are dissatisfied with funds of hedge funds manager fees. We wonder why: on top of the underlying hedge fund manager’s fees, funds of funds managers typically charge a 1% management fee, plus a 5% to 10% performance fee. (In our experience, the numbers are closer to 2% management fee and 20% performance fee.) Understandably, 60% of those that do not currently invest in funds of hedge funds say the greatest barrier is fees. Allrighty, then.


As expected (see C&C Newsletter for September 29, 2005, Item 5 and C&C Newsletter for November 3, 2005, Item 3), on July 18, 2006 the U.S. Securities and Exchange Commission issued an Interpretive Release narrowing the scope of permissible services under the soft dollar safe harbor contained in Section 28(e) of Securities and Exchange Act of 1934. The final rule, published July 24, 2006 in the Federal Register, is effective July 24, 2006. However, market participants may continue to rely on SEC’s prior interpretations of Section 28(e) until January 24, 2007. “Soft Dollar” arrangements are those under which a client may pay more than the lowest commission rate in order to receive “brokerage and research services” from a broker-dealer. The safe harbor protects money managers from liability for a possible breach of fiduciary duty to their clients for engaging in these arrangements at other than the lowest transaction costs, if they make a good faith determination that the amount of the commission was reasonable in relation to the value of the permitted services rendered. According to a piece from White & Case LLP, the release provides guidance with respect to the (1) appropriate framework for analyzing whether a particular service falls within the “brokerage and research services” safe harbor, with an emphasis on the scope of such services in light of evolving technologies and industry practice, (2) eligibility criteria for “research” and for “brokerage” and (3) appropriate treatment for “mixed-use” items. The release reiterates SEC’s views from previous releases on third-party research and provides guidance on client commission arrangements. A person provides research services if he furnishes “advice,” “analyses” and “reports,” each of which reflects “substantive contact and is the expression of reasoning or knowledge.” The release describes eligibility for the safe harbor of publications, market research obtained through order management systems, data services and proxy services. Brokerage services are services to effect the securities transactions themselves and functions incidental thereto, such as clearance, settlement and custody. The entire release is available at


Reuters reports that the assets of the world’s 300 largest pension funds rose 12%, to $9.4 Trillion last year, with Japanese, Norwegian and Dutch plans taking the top three spots by size of assets. Japan’s government pension plan is the world’s biggest, with $870.6 Billion in assets, followed by the Norwegian government’s at $235.85 Billion and the Dutch ABP‘s at $226.97 Billion. In dollar terms, the country that enjoyed the fastest pension asset growth was Mexico, up by 21% last year. Here is a table of the top ten plans:

Fund Country Assets (in $B)

Government Pension Investment Japan 870.6

Government Pension Norway 235.85

ABP Netherlands 226.97

National Pension Korea 214.2

California Public Employees U.S. 196.97

Pension Fund Association Japan 183.35

Federal Retirement Thrift U.S. 167.16

Local Government Officials Japan 137.15

California State Teachers U.S. 133.98

New York State Common U.S. 131.86

Incidentally, the Florida Retirement System, at $114.93 Billion is 13th largest in the world.


“Some people get so rich they lose all respect for humanity. That’s how rich I want to be.” Comedienne Rita Rudner

Copyright, 1996-2006, all rights reserved.

Items in this Newsletter may be excerpts or summaries of original or secondary source material, and may have been reorganized for clarity and brevity. This Newsletter is general in nature and is not intended to provide specific legal or other advice.

Site Directory:
Home // Attorney Profiles // Clients // Resource Links // Newsletters